Most of us are familiar with the term “cash flow” — it is the total monetary amount flowing in and out of a company. Knowing what it is and how to analyze it is paramount for small businesses that lack substantial cash reserves. Without cash flow monitoring and course correction, your business could quickly veer into the red, leaving you without the funds to cover your bills or pay your staff.
Tracking cash flow means accounting for past performance to help you make educated decisions regarding future projections. It empowers your company to operate more smoothly and to be ready for growth opportunities as they arise.
Read below to discover how to analyze business cash flow so you can adapt to revenue downturns and take steps to safeguard your bottom line.
What Is a Cash Flow Statement?
A cash flow statement is one of the most vital financial documents for your business. It can be as straightforward as a single-page analysis or could include multiple reports that feed information into a central statement.
A cash flow statement consists of three well-defined sections, each relating to a specific component of your business’s activities: operations, investing, and financing.
Cash Flow from Operating Activities
This section includes accounts receivables (AR), accounts payables (AP), and income taxes payable. Cash flow from operating activities measures the amount of money generated by your business’s normal operations. OCF will tell you whether your company can produce enough positive cash flow to sustain and expand its operations. If not, your company could require external financing to grow.
Cash Flow from Investing Activities
This second section on the cash flow statement analyzes the amount of money spent or generated from investment activities in a specified period. It allows you and potential investors to monitor how your company is investing in itself. Outflow activities might include vehicle, building, or furniture purchases. Inflow activities could include the sales of property, equipment, or investment securities.
Cash Flow from Financing Activities
Equity and debt transactions are recorded in this section. Cash flows that include the repurchase or sale of stocks and bonds, and dividend payments, are called cash flow from financing activities. Additionally, cash inflows from loans taken out or cash outflows from paying down long-term debt are recording in this section.
Useful Ratios to Unlock Your Company’s Financial Health
Cash flow ratios are powerful tools to aid you in summarizing your company’s cash flow statements and its financial health.
A thorough cash flow analysis can include several ratios. Below we’ve included three to give you a starting point so you can gauge the health of your company’s cash flow.
Cash Flow-to-Debt Ratio
Operations Cash Flow ÷ Total Debt = Cash Flow-to-Debt Ratio
Cash flow-to-debt (or cash flow coverage) ratio is your company’s operations cash flow to its total debt. Use this ratio to ascertain how long it would take your company to pay back its obligations if all of its cash flow was directed to debt repayment. Cash flow, rather than earnings, is used because it provides a more substantial estimate of your firm’s capacity to pay its liabilities.
Take the cash flow from operations from the cash flow statement and divide them by your company’s total liabilities, both short and long term. A higher ratio indicates your business’s ability to pay its obligations and its financial flexibility.
Cash Flow Margin Ratio
Operating Cash Flow ÷ Net Sales = Cash Flow Margin Ratio
The cash flow margin is an essential profitability ratio that can tell you how well your business can convert sales dollars into cash. This ratio is expressed as a percentage of your company’s net operating cash flow to its net sales (from your income statement). It will tell you how many cash dollars are produced for every sales dollar.
The higher the percentage, the better for your company. It is essential to watch how your cash flow grows as sales increase because they should be moving at a similar rate over time. If it’s not, you should find out why not and rectify the issue.
Free Cash Flow
Operating Cash Flow – Capital Expenditures = Free Cash Flow
Free Cash Flow (FCF) is a vital formula if you are looking to bring on investors or show creditors your company can meet its debt obligations.
It is the excess number of dollars a business generates after funding its operations and paying capital expenditures. An FCF ratio gives you a reliable picture of how efficient your business is at generating cash. Because it is difficult to fake the money flowing in and out of a business, investors view FCF as an honest look at how a company is performing and whether it will supply a return on their investment.
Ways to Shore Up Your Bottom Line
Performing a cash flow analysis can show you the next best steps to take for your business. If your business cash flow analysis demonstrates you are running low on cash and unable to make your payments, you can seek ways to modify your cash flow by:
- Cutting costs
- Boosting income
- Renegotiating terms with vendors
- Shortening your receivables window
- Looking for viable funding options
If your cash flow is still weak or non-existent, you may have difficulty paying your debts, which can hurt your credit. Poor credit can make it challenging to find traditional funding to help your business. This is where Revenued can help.
Benefits of a Cash Flow Analysis
Your company can earn a profit and yet still lack adequate cash on hand. If your clients owe on an invoice and haven’t paid on it, there may be no cash flowing into your business to cover your obligations.
Using a cash flow statement and financial ratios will give you a clearer understanding of where your money is coming from and where it is being spent. Once you have a handle on your cash flow, you will be able to expand your business, avoid excessive borrowing, and weather hard times.
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